Trade fears, social unrest in Hong Kong and Brexit uncertainties weighed on markets in August. Franklin Templeton Emerging Markets Equity expects continued volatility, but an interest-rate cut from the US central bank in September could help stabilize emerging market currencies. The team shares its latest outlook.

Three Things We’re Thinking About Today

  1. August saw US-China trade tensions escalate with several rounds of retaliatory actions following US President Donald Trump’s announcement early in the month of new tariffs on Chinese goods. The United States also formally labeled China as a currency manipulator after the Chinese renminbi depreciated to above seven per US dollar for the first time since 2009. These events sparked a broad and deep selloff in Chinese equities as well as global stock markets. However, we believe that China’s economy may be better able to absorb the trade issues than the market fears. It is important to note that China’s growth is now less dependent on trade than it was a decade ago. China’s trade balance with the United States has narrowed, and, at a current-account level, China’s imports of US services (as opposed to goods) has grown; China’s economy has been re-balancing with domestic consumption the key driver of economic growth. Policy changes in recent years, including a more flexible exchange rate, state-owned enterprise reform paired with support for private companies and looser monetary and fiscal policy, should also soften the US-China trade impact. Additional infrastructure investment may also be a key near-term support for China’s economy. It should also be emphasized any impact of the trade dispute is not limited to China. Recent data indicated a contraction in US manufacturing in August for the first time since 2016.
  2. Social unrest in Hong Kong, which entered its third month in August, has been adversely affecting key business areas in the city. A deterioration in the retail, hospitality and real estate sectors as well as a reduction in tourist arrivals has resulted in sharp share price corrections in related companies. While we expect the business environment to remain challenging in the near term as the government continues efforts to resolve issues, we anticipate some stabilization in the medium term. Moreover, we have also seen a number of companies implementing cost-reduction initiatives and streamlining operations, to support profitability and strengthen their overall business models. Although retailers have been especially impacted, it is important to note that some companies have substantial operations in neighboring markets, such as mainland China, which continue to contribute to earnings. Valuations have also become more attractive with decent dividend yields, which are particularly appealing in an environment of low interest rates.
  3. The Mexican economy has been buffeted by weaker-than-expected data and bouts of uncertainty. In the second quarter, gross domestic product (GDP) (on a year-on-year basis) contracted for the first time since the 2009 economic crisis. While we expect the volatility in financial markets to continue in the interim amid uncertainty about policies the newly elected administration will pursue, we believe the financials and consumer discretionary sectors remain attractive. Valuations have fallen to attractive levels, while profitability remains high. The domestic banking sector is underpenetrated compared to regional and global peers, especially in the consumer segment, providing strong structural growth potential. Separately, the country’s favorable demographics, which includes a young working population, also helps support consumerism. Moreover, Mexico has done quite well in positioning itself as a manufacturing hub for the United States. The cost of labor in Mexico is lower than China, so not only is Mexico well-positioned geographically in the supply chain, it is an inexpensive place for manufacturing and a potential beneficiary from US-China trade tensions. Remittances from the United States also aid the consumer sector.